Place (Distribution)
Place, more commonly called distribution1, includes
the organizations (a company and its partners),
locations (quantity and type), and processes (physical,
digital, intellectual) that:
- Enable the creation and fulfillment of
customer demand, and
- Provide any required post-purchase service.
Effective distribution provides customers with
convenience in the form of
- Availability (what, where, when - the right
product, at the right place, at the right time)
- Access (customers’ awareness of the
availability and authorization to purchase)
- Support (e.g. pre-sales advice, sales
promotion and merchandising, post-service
repairs).
Distribution management has both strategic and
logistical dimensions.
Strategic distribution is a competitive advantage
that accrues generally from the configuration of a
distribution network (who, what, where, when) and,
more specifically, from the selection of partners (i.e.
middlemen) who intermediate between the company
and the customer by performing necessary fulfillment
and service activities
Logistical distribution, which is geared to efficiently
supporting the strategic objectives, refers to the
storage and movement of goods, information, and
money between the manufacturer and the final
customer.2 Logistics is sometimes inappropriately
viewed as an exclusive operations function. In reality,
marketing often has a major role in the day-to-day
logistics process with functions ranging from sales
forecasting and demand management3 to inventory
© K.E. Homa 2000 – 2003
This note was developed by Prof. Ken Homa as background for
class discussions and is incomplete without extensive supplemental
oral elaboration.
1
In marketing jargon, “distribution” can be either a verb (to store
and move goods) or a noun (places where goods are available, or
entities involved in the distribution process).
2
The movement or “flows” can be bi-directional. Information is
constantly flowing in both directions. When customers return
products, the logistics are reversed: goods flow from the customer
back to the manufacturer, and money from the manufacturer to the
customer.
3
Demand management is a proactive effort to shape demand
patterns and customer expectations. For example, a company may
incentivize pre-season orders to level out production requirements.
04 Homa Note – Place (Distribution) r01-03
Revised January, 2003
planning and the allocation of short supplies.
Marketing decisions regarding the structure of a
distribution network (strategy) often set the bounds on
the logistics service quality a company delivers, and
the corresponding cost and investment economics.
Specific distribution-related decisions include:
(a) the number of layers between the company
and the customer (channel depth)
(b) the specific type of partners in each layer
(e.g. wholesalers or distributors, mass
merchants or high-end specialty retailers)
(c) the number of partners at each layer
(channel breadth)
(d) the placement of partners (location,
density).
These strategic and logistical decisions frame the
distribution channels (from a marketing perspective)
or downstream supply chain4 (from an operations
perspective) for a company’s products.
Distribution Strategy
More specifically, a company’s distribution strategy is
largely defined by decisions on the number and type
of customer interfaces. That is, order entry points
(where and how orders are placed) and fulfillment
nodes (where and how customers obtain finished
goods).
At the extremes are two fundamental fulfillment
options: direct distribution from the manufacturer to
customers, and intermediated (indirect) distribution
through aggregators that carry products from multiple
suppliers (who may themselves be complementors be
competitors).
For consumer products5, aggregators fall into two
broad categories: remote access (catalogers,
eCommerce companies) or local access (typically
brick and mortar retail stores).
Remote access fulfillment typically involves the
submission of an order via mail, telephone, or the
internet to a centralized site with shipments made to a
customer’s specified location from one or more
4
The “downstream” supply chain goes from the manufacturer to the
customer. The “upstream” supply chain goes from the
manufacturer back to the input sources (i.e. raw material, parts, and
component suppliers).
5
This note will focus on consumer products distribution. With minor
“tweaking”, the basic concepts are generalizable to industrial
products and services.
04 Homa Note – Place (Distribution) r01-03
remote distribution centers, usually via a 3rd party
carrier such as UPS or FedEx.
Local access fulfillment is the traditional and still more
prevalent form. Inventory is maintained at physical
outlets for immediate on-site purchase by customers,
or with remote orders placed for subsequent pick-up
by customers.
An increasing number of manufacturers have
implemented direct fulfillment capabilities.
Manufacturers that fulfill directly typically do so
remotely (from factories or central distribution
facilities), though some have local presence with retail
stores (e.g. Sherwin-Williams paints) or factory outlet
stores (which are primarily used to clear excess
inventories and outdated merchandise).
Some companies have coordinated their remote and
local capabilities. For example, Best Buy allows
customers to order on the web, and either receive
direct shipments or pick-up (or return) products at
local stores. Gateway has opened local stores for
demonstrating products and closing sales that are
remotely fulfilled.
In general, both direct and intermediated fulfillment
are becoming increasingly integral to most companies’
retail distribution strategy.
Retail Distribution Strategies
Page 2
1. Market Coverage
The primary objective of distribution strategy is to
provide sufficiently broad, gap-free market coverage,
i.e. being made available in enough outlets so that
customers have convenient access for purchases.
For some products, effective coverage is achieved
with exclusive or selective distribution through
relatively few specialized stores; other products (like
Coke) require intensive distribution with a dense,
often heterogeneous population of outlets.
The appropriate level of market coverage is situationspecific, depending on product characteristics, and
on customers’ buying behavior.
For example, exclusive distribution may be
appropriate for specialty goods (like expensive, high
fashion watches) that are sought out by customers,
that may require in-store selling, and that may even
accrue an “image halo” from the apparent exclusivity.
But, sales of frequently bought, commodity-like
products (sometimes called convenience goods) are
often driven by proximate availability, so intensive
distribution is usually appropriate and sometimes
mandatory6.
Many products follow a systematic progression over
their life cycle, moving from more exclusive to more
intensive distribution as the product matures.
The development of a retail distribution strategy
involves the type, number, and location of fulfillment
partners.
PLC Stage
For example, Coke seeks to be ubiquitous (“always
within an arm’s length”) with very broad distribution
across markets via numerous outlets of many different
types (e.g. grocery and convenience stores,
restaurants, vending machines)
At the other end of the continuum, some companies
choose to distribute their products through relatively
few, geographically clustered specialty stores (e.g.
innovative, tech-based entertainment products
distributed through electronics stores like Best Buy or
Circuit City).
A retail distribution strategy is primarily driven by three
inter-related objectives:
1. Broadening market coverage
2. Enlisting product support (from retailers)
3. Containing channel conflict (among
retailers, and across channels).
Primary distribution
Introduction
Specialty stores
Growth
High service
Maturity
Mass merchants
Decline
Lowest cost
Measuring coverage
Market coverage can be quantitatively characterized
as the number of outlets carrying a product as a
percentage of total outlets (sometimes called
distribution coverage or simply “distribution”), or
ACV (all commodity volume) - the percentage of
outlets carrying a product weighted by each outlet’s
category sales. For example, a small hardware store
would count equal to a Wal-mart store in a
6
A marketing cliché is that these products and brands can’t risk
being “out of sight, out of mind” and must, therefore, be “in sight
always”.
04 Homa Note – Place (Distribution) r01-03
measurement of distribution coverage, but would be
weighted less in an ACV metric.
Of course, the “quantity” of outlets carrying a product
does not necessarily connote distribution “quality”, so
metrics should be carefully tailored to reflect presence
in strategically appropriate outlets. In many instances,
being in the wrong places may more harmful than
being in too few places. In the development of a
distribution strategy, “quality” is both critical and very
specific with respect to product “fit” (e.g. prestige
goods in high-end outlets) and retailer support.
2. Product Support
The second retail distribution strategy objective is to
enlist product support. That is, to select and motivate
partners who:
(a) Maintain adequate inventories
(b) Display the product in desirable locations
(e.g. eye-level shelves, high traffic areas)
(c) Advertise and promote (special displays and
signing, discounted sales prices, inclusion in
flyers and ads)
(d) Sell the product (educating customers,
demonstrating the product, ‘closing the sale’)
(e) Install and service the product.
Measuring Support
Quantitative measures of support include the
percentage of category shelf space, share of ads or
promotions, the number of displays, order close rates,
and customer satisfaction indices.
The ultimate support metric, though, is share where
carried (percentage of category sales in stores that
carry the product) relative to overall market share.
Page 3
Exclusive and Shared Distribution
At the retail level, there are two distinct types of
distribution: exclusive distribution7 (the retailer
carries only one brand), and shared distribution
among many brands. For example, soft drink brands
share distribution in grocery stores (all major brands
are carried), but have exclusive rights at some venues
(e.g. restaurants, sports arenas, college campuses,
vending machines). Securing distribution at the
exclusive venues (that, by definition, offer 100% share
where carried) typically requires companies to deeply
discount prices or pay rights fees. Winning in shared
distribution is a function of traditional day-to-day,
hand-to-hand marketing combat, including strong
brand recognition, aggressive pricing, prominent
display presence, and demand-driving promotions.
Matching Products and Support
The specific support (level and type) that a product
requires hinges primarily on the product
characteristics (simple or complex; high end or mass
market; position along the product life cycle).
At the most basic intuitive level, the required support
depends on whether a product is “bought” (well known
and demanded), or needs to be “sold” (unrecognized
product, brand or need).
At one extreme, products that are highly innovative
(new technology or uses) and distinctive (from other
products and brands) may require aggressive selling
at store level to educate customers and close the
sale. So, specialty stores with highly motivated, welltrained personnel salespeople8 may be required,
especially during the product’s introductory phases.
At the other extreme, for commodity-like products that
are well known and understood, the distribution goal
may be to establish very broad distribution coverage
(i.e. a plethora of outlets, by type and in number).
Since the products do not require much explaining or
selling (i.e. they are bought not sold), the challenge is
simply to provide convenience (availability and
access), with occasional promotional emphasis. In
these instances, mass merchants and discounters
might be most appropriate.
7
Exclusive distribution is sometime called binary distribution
since it is an all or nothing proposition.
8
Often, the motivation is driven by manufacturer “spiffs” which are
special incentive payments made directly to salespeople based on
product-specific sales. Similarly, salespeople are often trained by
manufacturer’s representatives and provided with manufacturer
produced sales aids (e.g. sales scripts, FAQs, reference articles).
04 Homa Note – Place (Distribution) r01-03
Securing Distribution
Companies often find that their conceptualized ideal
distribution pattern may be constrained by the
willingness of retailers to carry and support the
product. Securing distribution is often a formidable
challenge, especially for small or unproven companies
or brands.
In general, retailers make decisions on whether or not
to carry a specific product based on the prospective
retail profitability of the products.9 Among the
factors commonly considered are:
(a) gaps (versus duplication) in the retailers
product line assortment
Page 4
Slotting Fees
In part to defray initialization costs and mitigate risk (to
the retailer), an increasing number of retailers have
instituted slotting fees, payments made to the retailer
whenever new products are adopted.
Many retailers set their slotting fees based on very
liberal cost accounting that may overstate their
incurred costs, and some even include an explicit
profit mark-up that is over and above their set-up
costs. The net effect of the escalating slotting fees is
to raise the ante for securing distribution, sometimes
to a level that erects de facto economic barriers,
excluding all but the biggest, most deep-pocketed
suppliers.
(b) track record (credibility) of the supplier
(c) projected retail margins (initially and over time)
(d) anticipated promotion support
(e.g. advertising, displays, “deals”)
(e) compatibility of logistics infrastructures
(location of facilities, information systems)
(f) the supplier’s market position (clout)
Historically, manufacturers - especially big national
brands – held the balance of power over most
retailers and could, more or less, force them to carry
products and provide support. In the past couple of
decades, though, the balance of power has generally
shifted to the retailers, largely due to retail
consolidation (the big have gotten bigger) and the
emergence of power retailers like Wal-mart and
Home Depot.
Still, large prominent brands and companies (like
P&G, Kellogg) that have proven track records,
established customer relationships, and in-place
infrastructures (e.g. regional DCs, real-time data links)
have an advantage securing distribution quickly and
broadly with target accounts, especially for new, high
margin products. The potential financial returns for
retailers are relatively high, risk is contained, and
sometimes from a pragmatic perspective, the retailer
has no real choice.
On the other hand, while small upstart companies
may crave distribution through the power retailers,
they often find that the high-volume retailers are
reluctant to take on the cost burden and risk of
reallocating valuable shelf space to unproven
suppliers, brands, and products.
3. Channel Conflict
The third retail distribution strategy objective is to
contain channel conflict.
Given that their prospective profitability is the primary
reason that retailers carry products, projected profit
margins and sales volume are critical variables.
On a macro basis, a product’s inherent market value
drives customer demand, and largely determines
aggregate sales volume and average pricing.
On a more micro basis (i.e. from the perspective of a
specific retailer), sales are a share of the total sales
volume in a specific trading area and margins are a
direct function of prevailing (or lowest prices) offered
by competing retailers.
Horizontal Channel Conflict
The implication is that the intensity of competition
among retailers is a major driver of retailer support (or
lack thereof). Invariably, as a product’s distribution
base is broadened (more accounts, stores, and types
of stores are added), the likelihood of horizontal
channel conflict10 increases. As channel conflict
increases, retailers’ support for a product typically
deceases. While channel conflict can rarely be
eliminated completely, it is critical to contain it.
In most instances, horizontal channel conflict boils
down to a question of economics: retailer profits are
pushed below acceptable levels as a result of direct or
10
9
Sophisticated retailers think in terms of direct product
profitability per linear foot, i.e. the true net profit a product
generates relative to the space allocated to the product.
Horizontal channel conflict is between and among organizations
operating in the same “layer” of the distribution network. Vertical
channel conflict, which will be discussed later, is between
organizations at different levels of the network, e.g. between
manufacturers and retailers.
04 Homa Note – Place (Distribution) r01-03
indirect competitive behavior.
Horizontal channel conflict is increasingly common in
real life as companies attempt to reach different
customer segments by utilizing multiple distribution
channels (including direct from the manufacturer).
More specifically, when multiple channels are
employed and distribution intensity increases, three
profit threats may confront a retailer: sales
cannibalization, margin dilution, and customer
diversion11.
Consider the following cases:
(a) A mature, commodity-like product is sold through
traditional grocery stores that attempt to maintain
margins at roughly 30%. The manufacturer
makes a comparable product available through
warehouse club stores that price to operate at 5%
margins by maintaining a very bare bones
overhead structure12.
(b) A broadly distributed, heavily advertised, branded
product becomes a ”traffic builder” for some
retailers. That is, they price the product at or
below cost to attract customers to their stores,
hoping that the customers will also purchase other
higher margin merchandise.
(c) A new, complex product is introduced though a
select group of specialized retailers who compete
on service (i.e. front-end consultive selling) not
price. As volume builds for the product, similar
versions are offered through “category killer”13
discounters who offer no in-store service and
compete based on low prices.
(d) A manufacturer that has traditionally sold its
products through full-service specialty retailers
decides to have its salesforce call directly on
particularly large customers, bypassing the
retailers, and decides to hop on the eCommerce
bandwagon by selling to price-sensitive customers
via the internet at “factory direct” prices.
11
Customer diversion is sometimes referred to as “channel
leakage”.
12
By law, manufacturers may not dictate intermediaries’ prices.
The practice, called retail price maintenance, was at one time
allowed under so-called “Fair Trade” laws that were intended to
protect small and full service stores. Now, manufacturers may
suggest but not enforce MSRPs (manufacturer’s suggested retail
prices).
Page 5
In all of the above cases, there is the potential for
significant channel conflict that is virtually certain to
deteriorate retail economics (i.e. lower sales, prices,
and profits), which may result in a reduction of
aggregate support for the products.
In case (a), if the grocery stores don’t narrow the price
spread, they will have some of their sales
cannibalized by the warehouse stores and will likely
lose market share since the market is mature (i.e.
slow / no growth).
In case (b), all retailers are likely to suffer margin
dilution to the extent that they cut prices (either on an
everyday or promotional basis) in an attempt to
maintain their market shares.
In case (c), the full service stores may have some of
their customers diverted to the discounters. That is,
customers may take advantage of the pre-sales
service, but then buy at the low price outlet. Or the
stores may suffer margin dilution if they accede to
customers who benchmark against “low-balling”
competitors and negotiate lower prices14.
Case (d) is often the most controversial and emotional
of the channel conflict situations since the
manufacturer is involved. The specialty store may be
hit by a profitability triple threat: some sales will
cannibalized by the manufacturer’s direct sales force;
some full-service customers will be diverted to buy
directly from the manufacturer; and margins will be
diluted if prices are reduced to match the factory
direct prices.
In both cases (c) and (d), the full service retailers are
likely to become economically demotivated and shift
their sales attention to more profitable products. As a
result, the product may lose its primary sources of
market support.
As the above cases illustrate, the dominating
distribution objective, broadening market coverage
(i.e. increasing customers’ convenience), is somewhat
at odds with the other two - enlisting product support
and avoiding channel conflict. While a company may
want broad rather than selective distribution, and may
want to attack different market segments though
multiple channels of distribution, the stark reality is
that intensive hybrid distribution may, if not very
carefully managed, result in horizontal channel
conflict, deteriorating retail economics, and eventual
loss of critical retail-level product support.
13
Retailers like Home Depot, Staples, and Toy ‘r Us are usually
called category killers since they dominate their respect product
categories with very high, concentrated sales volume driven by low
prices. Traditional retailers sometimes call this type of retailer
”category margin killers” because of their low price strategies.
14
This customer practice is commonly referred to as “best-balling”,
i.e. negotiating based on the lowest price found in the market.
04 Homa Note – Place (Distribution) r01-03
Page 6
Mitigating Channel Conflict
Distribution Logistics
While some level of channel conflict is inevitable,
especially as products mature, it can be (and should
be) mitigated.
The second dimension of distribution is logistical.
In order to contain the level of conflict, companies
need to embrace distribution philosophies that:
(a) Adopt a long-run perspective and refrain from
opportunistic initiatives that may jeopardize
established channel relationships for the sake of
potentially transient short-term gains.
(b) Are respectful of system economics,
recognizing that channel partners must earn
fair financial returns to stay motivated.
Again, a company’s distribution strategy is largely
defined by decisions on the number and type of
customer interfaces.
Once the retail distribution strategy is set, the
management focus shifts to distribution logistics (i.e.
moving goods from the manufacturer, through any
intermediaries, to the customer).15
To achieve its strategic distribution objectives, a
company may choose to use few layers of
intermediaries (called short distribution channels),
or relatively many layers (long distribution
channels).
(c) Stay open and flexible by avoiding restrictive
long-run agreements (formal or “common
law”) that foreclose adaptation to changing
markets.
Manufacturers
On a more tactical level, companies should:
FritoLay
(a) Avoid premature distribution through
margin-crunching channels despite their
sometimes alluring potential to satisfy the
“thrill of volume”.
TrueValue
Dell
Retailers
Home Depot
(b) Delineate clear rules for territorial
coverage and “account ownership” so
that competing channels (including the
manufacturer direct channel) avoid fighting
over the same set of customers.
(c) Build and maintain “fences” between
competing channels to minimize leakage.
For example, many companies market
different brands to different intermediaries, or
offer derivative models that are similar to, but
different from their base products, that
match the needs of different channels (e.g.
newest full featured models to specialty
stores, older “stripped down” models to
discounters), and that “shelter” retailers from
head-to-head price competition.
Distributors
Customers
End Users
For example:
Dell sells directly to customers.
Frito Lay distributes directly to retail stores.
Home Depot stores receive most shipments
directly from manufacturers.
Cotter- TrueValue (a hardware cooperative) receives
shipments from many manufacturers and redistributes
to independent hardware retailers
15
For logical simplicity, this discussion considers the link between
strategic and logistical distribution to be sequential. In reality, the
linkage iterative, not sequential.
04 Homa Note – Place (Distribution) r01-03
At one extreme, the shortest of channels is direct
distribution, i.e. a customer places an order directly
with the company, and the company ships the goods
directly to customers.
In the ‘old days’, direct distribution was largely
restricted to higher priced products (like industrial
equipment) or to companies with relatively broad lines
of high volume products that could be aggregated to
provide the necessary operating efficiencies of scale
or scope (e.g. catalog companies like Lands End).
Page 7
Several insights can be drawn from this simple
illustration and common sense:
(a) Intermediaries can add real value. Broadly
speaking, intermediaries typically perform one or
more of four basic functions:
Breaking Bulk: taking large quantities (truck loads,
pallets) and “breaking” them into smaller units (e.g.
mixed cases of individual units)
Modifying products in ways that range from simple
repackaging, labeling, and price-marking to light
manufacturing and final assembly (e.g. merging
base products and locality-specific add-ons such
as power supply modules)
In the digital era, an increasing number of companies
are willing and able to distribute to customers directly.
From a logistical perspective, the web provides a
cheap, effective way to process customer orders, and
efficient package delivery networks (UPS, FedEx)
provide a relatively cost-effective way to transport
small quantity orders directly to customers. Further,
since finished goods inventory can be centralized,
service levels can be maintained at high levels with
relatively low stocks (largely because of lower
required safety stocks).
At the other logistical extreme are long, highly
intermediated distribution channels. For example
a company may sell to a specialized distributor who
sells to a wholesaler who sells to a retailer who sells
to a final customer.
Creating assortments: gathering products that
customers want to receive on single orders.
Batching orders for improved operating efficiency
(b) Intermediaries can materially improve
distribution economics. From an economic
perspective, a manufacturer may lack the scale,
scope, systems or specialized knowledge
required to perform all distribution activities
effectively.
As in the illustrative situation above, a distributor
may be able to aggregate products from multiple
suppliers and sort orders from many customers
into economical batches that enable cost-effective
order processing and transportation16.
Rationale for Intermediation
The rationale for intermediation can be illustrated with
a very simple illustration: consider a relatively small
set of 5 complementary suppliers that all sell to a
common population of 100 customers. If each
supplier were to sell directly to all of the customers,
there would be 500 supplier-customer interface links
(5 suppliers times 100 customers).
Further, intermediaries may have, based on their
experience, developed best practices (i.e. tailored
operating procedures) that may be supported by
targeted investment in specialized, high-efficiency
equipment. Manufacturers may be reluctant to
make such specialized investments.
What if, an intermediary were inserted between the
suppliers and the customers to aggregate products
from the 5 suppliers for shipments to the same
customers? That is, customers place orders with the
aggregators and receive consolidated shipments
directly from them.
And more broadly, manufacturers may have no
practical choice but to engage intermediaries as a
means of syndicating investment. For example,
it would be financially prohibitive for soft drink
companies to own all of the bottlers in their
worldwide distribution network, even if such
structure would be strategically desirable. The
investment would simply be too big for any one
company.
Simple mathematics simplifies the system by cutting
the number of interfaces from 500 to 105 (5 links
between suppliers and the aggregator, and 100 links
between the aggregator and the customers).
16
Transportation rate schedules significantly disadvantage small
shipments that are inherently costly. The most expensive
combinations are small quantities (like single units) shipped for fastdelivery (same or next day).
04 Homa Note – Place (Distribution) r01-03
(c) Intermediaries can develop extraordinarily
deep market presence and customer
relationships.
Often, intermediaries have particularly keen market
knowledge since they are closer to the market than
manufacturers.
Some customers prefer dealing with intermediaries
since they simplify transaction interfaces
(efficiency), offer a broad line of products (choice),
and provide an apparently independent, customeroriented perspective (impartial credibility). As a
result, intermediaries often develop strong,
leveragable relationships with customers that
manufacturer’s have difficulty replicating. Said
differently, a drawback of intermediation is that it
distances manufacturers from their customers.
Channel Length
Most typically, the length of distribution channels falls
somewhere on the continuum between direct and
heavily intermediated.
From a conceptual perspective, the decision as to
where on the continuum a company should operate
depends on two key factors:
(a) Scope and nature of the value added
services required to take a product from the
manufacturer to customers
(b) Relative effectiveness (cost and service
quality) of alternative providers of the
services
Value-added Distribution Tasks
More specifically, certain value-added logistics tasks
must be performed to distribute a product.
In the simplest cases, a customer order must be
processed (received, validated, credit checked,
matched to inventory, scheduled for shipment) and
the product shipped to the customer, either from the
end of the production line (make to order) or out of
some company’s inventory (make to stock).
In more typically complex cases, products may need
to be bundled with other products (e.g. to compile a
usable system, or to accrue quantity discounts for
transportation economies), slightly modified to meet
customer specifications (e.g. small features added or
deleted, bulk quantities may be packaged into smaller
units), installed and fine-tuned at the customer site,
and serviced after it is put in use.
Once the necessary value-added activities are
Page 8
identified, the pivotal question is: who can most
effectively perform the activities from both cost and
quality perspectives - the company or third party
intermediaries.
If a company operates under the direct model, it must
perform all of the value added activities. By doing so,
the company is able to retain all of the system profits
(the difference between total accumulated costs and
the price customers pay for the product).
If a company has an infrastructure in place (facilities,
people, systems) and has adequate relevant scale
(i.e. enough volume to make operations economical),
then direct distribution may be a viable alternative.
Channel Disintermediation
During the eCommerce frenzy, many start-ups built
their business propositions on the back of
disintermediation – that is, eliminating one or more
participants in an established supply chain.
The rationale for disintermediation was that
eliminating “costly middlemen” could increase system
profits (by paring unnecessary activities and costs)
and would shift profits to the disintermediator.
So, by distributing more directly to customers (i.e.
disintermediating), eComm companies could, at least
in concept, cut prices (passing along some of the cost
savings) and earn high profits (in part by recapturing
profits currently being pocketed by the middlemen).
But, sometimes lost in the disintermediation frenzy
was the very basic fact that most (if not all) of the
activities that intermediaries do, need to be done by
somebody. If the intermediaries don’t do them, then
either the company must, or customers must (e.g.
placing orders directly via the net, picking-up
merchandise at drop-off depots, getting help from
‘intelligent’ phone systems). By definition, necessary
value-added activities don’t just go away!
In many (bordering on most) instances, companies
find that intermediaries (such as distributors) have
better facilities, have specialized knowledge and
processes, and have the relevant scale (an adequate
volume of related products) to do a more efficient job
on many value added activities.
For example, an industrial products distributor can
assemble big, multi-product orders that are more
economical to ship.
And, with very few exceptions (e.g. Gateway,
Sherwin-Williams, the Gap), manufacturers conclude
that operating their own brick and mortar stores are
neither necessary nor economically viable.
04 Homa Note – Place (Distribution) r01-03
Many companies that tried to disintermediate
discovered that they are not capable of performing
many of the tasks economically since they don’t have
the necessary economic scale or specialized
competencies. The disintermediated systems turn out
to be less quality- and cost-effective, and the
companies are forced to reintermediate, by adding
complementary intermediaries.
Outsourcing
Similarly, many companies that have traditionally
distributed directly to customers have started
outsourcing distribution activities to third party
experts.
These companies have concluded that basic
distribution activities are important, but not strategic to
their businesses, that they lack core competencies in
the functional areas, and that they lack the relevant
volume to be cost-effective.
They enlist the services of specialized distribution
companies and turn over all or parts of the distribution
processes to them. In other words, they intermediate
systems that were previously disintermediated.
The bottom line is that while some intermediaries may
be inefficient or gouge for unreasonably high profits,
the evolutionary survivors are typically effective at
their specialized tasks (i.e. competitive costs and
quality), and price their services for a fair profit.
So, most companies optimize their cost and quality of
service through a network of intermediaries, each
performing some necessary value added activities for
which they are compensated (to cover their costs and
generate profit).
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Supply Chain Management
Managing a network of intermediaries is a formidable
challenge, especially for long distribution channels.
From the logistical perspective, the process is called
supply chain management (SCM).
SCM’s goal is to construct a chain of partners that
optimizes cost and service quality as a system (i.e.
achieving a global optimum).
More specifically, there are four keys to effective
supply chain management:
(1) Smooth synchronization: of activities
(2) Fact-based evaluation of performance
(3) Fair compensation for services
(4) Authentic commitment to partnership
(1) Synchronization
Synchronizing the supply chain is, in essence, getting
all of the partners operating in a manner that is
mutually supportive (flexible, cooperative) and
seamless (smooth, unnoticed by customers).
The synchronization process starts with a clear
definition of roles and responsibilities. That is,
making sure that all supply chain partners know
specifically what tasks they are expected to perform
(e.g. storing goods, modifying them, reassembling
quantities, price marking), when they are expected to
do them (lead times and deadlines), how they are
expected to perform them (i.e. to what operating
specifications), and what results are expected (sales
quotas, customer satisfaction ratings).
Often, vertical channel conflict (i.e. between layers
of the supply chain) occurs due to ambiguous or
conflicting roles and responsibilities. That is, conflicts
such as poor service levels, passive sales efforts, and
missed deadlines.
04 Homa Note – Place (Distribution) r01-03
On a day-to day basis, many tasks and activities
require operating synchronization: entering orders,
conforming schedules, tracking shipments,
communicating status information, invoicing, collecting
payments, processing returns, resolving disputes17.
Whenever a partner has a process failure, the entire
supply chain may be disrupted and annoying
operational conflict may occur.
PSI Planning
Over time, the bulk of the operating synchronization
activity is PSI planning (production, sales, and
inventory) which is the information-based scheduling
of product flows throughout the system.
PSI planning, which is a marketing functional
responsibility in many companies18, begins with a
forecast of future demand (unconstrained by
operational factors such as capacity limits) that is
meshed against current and targeted inventory levels
(depleting excesses, accumulating for peak periods)
to determine a desired level of new production. The
manufacturing functional organization then applies the
constraints19 to set a feasible production schedule.
The planned new production is matched with the
inventory plan to determine the expected level of
anticipated sales (demand adjusted for constraints)
that can be reflected in sales quotas and sales
compensation schemes.
Keeping in mind that distribution is granular and
temporal (i.e. the right product at the right place at the
right time), the PSI must be planned for each step or
stage in the supply chain20. So, as supply chains get
longer (i.e. more layers added) and more complex (i.e.
more types of intermediaries), the PSI planning
process becomes more challenging.
The key to effective PSI planning is accurate, timely
information flows.
Supply chains move both goods and information, and,
generally, it is both cheaper and faster to move digital
information than physical goods.
17
It is increasingly common for many of these tasks to be executed
digitally (i.e. computer-to-computer), elevating the need for
companies to implement reasonably state-of -the-art information
systems that are compatible with those of adjacent supply chain
partners.
18
Some companies assign PSI planning to logistics organizations;
an increasing number of companies are now establishing dedicated
organizations called “Supply Chain Management”. Even under
these organization schemes, marketing plays an important role.
19
These constraints may be hard constraints (can’t) or soft
constraints (don’t want to). For example, plant capacity is a hard
constraint; unwillingness to work overtime is a soft constraint).
20
This granular level of planning is usually called DRP: distribution
requirements planning
Page 10
Demand Flow – ECR
Accordingly, many supply chains have shifted from a
traditional push system (the manufacturer projects
demand and pushes inventory to intermediaries who
are responsible for storing the inventory until it is sold
through) to an efficiency-based pull or demand flow
system (real-time information triggers orders for
inventory that flows through the system).
Companies that plan effectively based on real-time
information are able to eliminate inefficient physical
moves (e.g. accumulation of excess or obsolete
inventory, premium transportation for small
shipments) and dramatically increase the efficiency of
their supply chains
Some companies have taken PSI planning to very
high levels of cooperative sophistication.
For example, P&G was the pioneer in a process
called efficient customer response. The essence of
ECR is to link the supplier (P&G in this case) with
distribution channel partners (such as Wal-mart and
Kroger) so that real-time PSI information flows in up
and down the supply chain (from supplier to retailer
and back) as a basis for scheduling operationally
efficient movements of goods. ECR is the current
pinnacle of supply chain synchronization.
(2) Performance Evaluation
The second key to effective supply chain
management is fact-based evaluation of performance
of supply chain partners.
These evaluations should be on-going (bordering on
real-time), objective (i.e. quantitative whenever
possible), and directly linked to customers’ escalating
service quality expectations.
For example, customers reasonably expect at least:
- Hassle-free order entry (prompt, user-friendly)
- High fill rates (available when ordered)
- Consistent cycle times (predicable order to
receipt times)
- Dependable deliveries (on time, intact)
- Timely order tracking (real-time status)
- Accurate invoicing (right quantities and prices)
- Appropriate post-sales service
(installation, returns, repairs)
So, specific metrics should be adopted that measure
performance along these dimensions.
04 Homa Note – Place (Distribution) r01-03
Page 11
For example, consider the soft drink industry’s
economic profile:
(3) Fair Compensation
The third key to effective SCM is fair compensation for
services provided.
The underlying principle of fair compensation is that
all high performance supply chain partners are entitled
to earn an acceptable return for the value added
services that they provide.
-------------------- Value Added --------------------
Market
Value
(a) Concentrate producers (Coke, Pepsi) earn high
ROIs, driven by very high margins on syrup, a
relatively low investment in physical assets, and
high spending on brand-building promotion;
(b) Bottlers, who generally have less aggressive ROI
targets than the CPs, have substantial investments
in assets (bottling plants, trucks), earn modest
margins from retailers and restaurants, and earn
very high margins on vending machines;
Profit
Costs
Profit
Costs
P
R
I
C
E
Profit
Costs
Parts
&
Matl
SUPPLIER
MANUFACTURER
DISTRIBUTOR
RETAILER
Customers pay some final price to acquire a product
based on how they value the perceived benefits that
the product delivers.
The price paid can be thought of as the sum of the
accumulated costs (e.g. basic inputs like parts and
materials, and the cost of value added services), the
aggregate profits earned (at each step of the supply
chain), and the actual value added (reflecting how
much customers benefit from the product).
The difference between the price and the
accumulated costs is the aggregate profit to be shared
by supply chain partners.
Assuming that aggregate profits are generally fair, the
question is how to apportion the pool, and whether the
result is specifically fair to each supply chain
participant.
At all levels, partners expect (and are entitled to) fair
profits. These profits are most appropriately
evaluated relative to the corresponding level of
investment, i.e. the ROI earned.
If all performing partners (high quality, low cost) earn
an acceptable return (based on their goals), the
system is in equilibrium. If partners are
undercompensated (again, based on their
expectations), they are likely to opt out of the system
or compromise the quality level of services provided.
(c) Retailers (like grocery chains) earn high ROIs
despite low percentage margins, because they get
substantial promotional support from concentrate
producers and bottlers that accelerates inventory
turnover to very high levels;
(d) Restaurants earn high ROIs from very high
margins on beverage sales that complement their
lower margin food sales.
The bottom line is that all channel partners in the soft
drink supply chain earn acceptable returns (albeit in
very different ways, and based on their idiosyncratic
internal goals) and the system is, more or less, in
equilibrium.
(4) Partnership Commitment
The fourth key to effective supply chain management
is an authentic commitment to partnership.
In the past, supply chain relationships were often
arm’s-length and sometimes adversarial. Now, most
companies recognize that an efficient supply chain is
a competitive necessity that is best achieved through
“true” cooperative partnerships that include:
(a) Agreement to mutually beneficial objectives
(strategic and operational)
(b) Confidence in respective abilities to execute (to
minimize “checking” and task duplication)
(c) Openness, including a willingness to share
proprietary information (i.e. “open the books”)
(d) Timely and forthright communications regarding
both opportunities and challenges
(e) Flexibility to respond to “outlier” situations such as
rush orders, special handling, credit crunches.
(f) Adaptability to change, including a willingness to
“go own ways” when interests diverge.
*******
04 Homa Note – Place (Distribution) r01-03
Conclusion
Distribution, which is arguably the least understood
and most overlooked of the traditional marketing Ps
(place), is becoming central to many marketing
strategies (especially in electronic commerce) and
fundamental to a companies’ operational
effectiveness.
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